Budget 2022 unlikely to provide capital infusion for banks for the first time in over a decade

With capital infusion of Rs 3.36 trillion during the last six years from the Government of India, public banks have significantly cleaned up their balance sheets with the net non-performing advances (NNPAs) reducing to 2.8 percent as on September 30 from the peak of 8 percent as on March 31, 2018. With high provisions on legacy stressed assets, the earnings outlook for public banks also seems healthy as we expect most public banks to incrementally remain profitable, and generate growth capital requirements internally.

Public banks were also able to roll over the Additional Tier-I bonds that were due for call option in FY2022, reflecting strong investor appetite for their issuances, and boding well for their future issuances. With cleaner balance sheets, and an improved earnings outlook, the banks can also tap capital from market sources as they have done in recent years. Accordingly, for the first time in over a decade, we do not expect any capital to be budgeted by the government for public banks despite the enhanced regulatory capital requirements.

After consolidation among public banks, the previous Budget announced the privatisation of two public sector banks. As expected, the proposal faced political headwinds apart from opposition from the employee unions. With an eye on the upcoming state elections, the Banking Laws (Amendment) Bill, 2021 has not yet been introduced in Parliament. As a result, visibility on such divestment remains low even in the next fiscal. Further, the regulatory stance on allowing the entry of large corporate houses remains uncertain, which may constrain the available options for the government to attract potential investors.

The banks that were left out of the consolidation exercise are highly likely candidates for potential divestment, but even the smallest of these banks has a balance sheet size of over Rs 1 trillion. This means that the new owners must have deep pockets as their preference will be for holding a majority stake in the bank initially, which will also require regulatory blessings. A part of such majority ownership is also likely to involve fresh capital infusion into the bank for strengthening the balance sheet and growth. Hence, the divestment may not simply include a stake sale by the government and, therefore, inflow from divestment could be lower.

However, as per various reports, the government proposes to retain a 26 percent share in the bank as a part of the privatisation process, and this could provide it with upside potential if the new owners can create better value for the institution. Minority ownership by the government will also maintain depositors’ confidence in the bank, and help the new management retain and grow the deposit base while instituting asset-side strategies led by process changes and upgrade of employee skills.

The other budgetary proposal included the creation of an asset reconstruction company (ARC), and the transfer of bad loans of banks. As a step towards operationalisation of the ARC, various banks have subscribed to the capital of national asset reconstruction company limited (NARCL), and the NARCL also received the license from the regulator. Further, the government has also announced a sovereign guarantee of Rs 306 billion for the security receipts (SRs) to be issued by the NARCL against the NPAs purchased from the banks.

These guarantees propose to make good the amount of shortfall upon the resolution of the NPAs, and the value of these SRs. These SRs are likely to be issued for the NPAs of Rs 2 trillion, and the government has effectively written a put option for SR investors or assured a floor price for recovery against these NPAs. In case the recovery exceeds the government’ estimates, the guarantee will not devolve, and the banks would see an improvement in their profitability as these accounts are fully provided for. In a scenario where the recoveries fall short of estimates, the banks have a chance to recover the minimum assured amount by way of guarantee invocation.

The success of the NARCL will, however, be driven by the ability of the banks to identify stressed accounts early on in future, and implement a co-ordinated resolution approach through the consolidation of debt at the NARCL so that value maximisation can be achieved for the banks.